“Shadow” Insider Trading – SEC Wins Jury Trial in Closely Watched Insider Trading Case

Last week the SEC notched a win in its first “shadow” insider trading case when a jury returned a verdict for the SEC after only two hours of deliberation. However, back in 2021, the SEC was met with a hail of criticism when it brought this first, and so far only, shadow insider trading case against Matthew Panuwat. The enforcement action was labeled, among other things, unfairly novel, a violation of due process, regulation by enforcement, and a unilateral expansion of the law by the SEC. This blog disagreed at the time and pointed out that, while the case may have been the first of its particular type, “shadow” insider trading fits squarely within the existing legal framework of insider trading (see here for the explanation). More relevant than this blog, the District Court hearing the Panuwat case twice sided with the SEC in holding that the shadow insider trading case was on solid legal footing. First, in denying Mr. Panuwat’s motion to dismiss the case the Court held that the SEC’s shadow theory was within the established law of insider trading (this blog’s discussion of the decision is here). Later, after discovery had been completed, the Court denied Mr. Panuwat’s summary judgment motion and found that there existed sufficient evidence to support the SEC’s legal theory. But what about a jury – would a jury understand the concept of shadow trading and be willing to find liability based on the SEC’s circumstantial evidence? The SEC’s trial win answered those questions.

Matthew Panuwat was an executive at a publicly traded biopharma company called Medivation, Inc. Mr. Panuwat learned in the course of his employment that Medivation was going to be acquired by Pfizer. Less than 10 minutes after learning that nonpublic information, Mr. Panuwat bought short-term, out-of-the-money call options in a different company – a company that was comparable to Medivation called Incyte. Trading Incyte options was the novel twist in this case because the material nonpublic information Mr. Panuwat had was “about” Medivation, not Incyte. When the acquisition of Medivation was announced the stock price of Incyte went up about 8% and Mr. Panuwat made a profit of over $100,000 on his options trades.

The SEC’s evidence on the necessary elements of insider trading was strong and the case was ideal for the SEC to bring as its first shadow trading case. As to duty, the Medivation insider trading policy prohibited trading in the securities of any company based on confidential information learned at Medivation (many companies’ trading policies only prohibit trading in the company’s securities). Many commentators have rightly wondered if the SEC would have brought this case if the trading policy prohibited trading only in Medivation’s securities. Following this case, the answer is that the SEC is more likely to bring such a case because the District Court, in its summary judgment ruling, held that a duty for insider trading purposes can also be created just by the act of a company entrusting an employee with confidential information. Expect this basis for a duty to be asserted in future cases involving employees where there is any ambiguity in the company’s insider trading policy (or the absence of an insider trading policy, as is the case in many private companies – and yes, an employee of a private company can acquire MNPI about a public company in the course of their employment).

On materiality, Incyte had been identified by the investment bankers working for Medivation as a peer company to Medivation and used in their analysis as a comparable company. When the Medivation acquisition was announced the price of Incyte did go up about 8% and an expert for the SEC testified that Incyte’s rise was caused by the Medivation acquisition news. Mr. Panuwat’s own action in trading Incyte just minutes after learning of the Medivation acquisition also was evidence that the information was material to Incyte. In other words, there was sufficient evidence that although the confidential nonpublic information was about Medivation, it was material to Incyte. That conclusion is not surprising to anyone familiar with the markets as sometimes news about one company predictably does impact the market price of one or more other companies.

On scienter, or showing that Mr. Panuwat was knowingly trading on the news of the Medivation acquisition, the SEC presented evidence that he placed his options trades just 7 minutes after he learned of the acquisition from an email from Medivation’s CEO. The options were short-dated, out-of-the-money call options, a risky short-term bet with the potential for a large profit. The dollar value he wagered was five times larger than any other options trade he had ever placed and amounted to about half of his annual salary. He had never traded Incyte before and at his deposition he testified that he did not remember why he bought Incyte call options. However, at trial he recalled that he bought the options because of an analyst report he had read – an inconsistency the SEC highlighted for the jury. In other words, the trial featured a typical SEC circumstantial insider trading case where the totality of the circumstantial evidence can paint a fairly damning picture. Commentators are correct to highlight the legal questions raised by shadow trading, but the Panuwat trial is a good reminder that most insider trading investigations and trials are really mostly focused on the facts and the story they tell. That the jury deliberated for only two hours suggests the SEC did a good job of using the evidence to tell a compelling story.

That is not to say that some criticism of the SEC’s case wasn’t warranted. It is true that many people do not naturally equate shadow trading with illegal insider trading. Therefore, ideally the SEC would have warned market participants about shadow trading before bringing its first enforcement action. The little-used Section 21(a) “Report of Investigation” would have been an ideal resolution to this case since it was without precedent and an effective way to provide a warning to the market that shadow trading is a form of insider trading. It is worth pointing out that this is a civil case and the Department of Justice did not bring a parallel criminal action. Where company executives use company material nonpublic information to trade, it is common for there to be a parallel criminal prosecution. No doubt the absence of the DOJ reflects the different evidentiary and the heightened due process considerations specifically because this was a new type of insider trading case.

It seems certain that the Court’s rulings upholding the SEC’s legal theory, and the jury’s validation of the SEC’s circumstantial case, will embolden the SEC to continue bringing shadow trading cases. Traders therefore need to consider shadow trading in their compliance programs. One of the main challenges shadow trading will present for market participants is the sometimes difficult assessment of materiality. At what point does information “about” one company become material to a different company? If one has MNPI about one company, does that mean they have material nonpublic information about all the companies in the same sector? The answer is that the established, broad definition of materiality – would a reasonable investor think the information is important to the security being traded – remains the test. The challenge is in correctly applying it. Most market participants have extensive experience weighing if information is material to the company the information is about. However, they are not accustomed to thinking about materiality as to other companies and do not have a track record of observing the market impact of information about one company on other companies. Moreover, the materiality to the company that information is about is often unclear and difficult to assess with certainty. It adds another layer of difficulty to correctly assess whether information about one company is material to another company. Hopefully the government recognizes this challenge and confines itself to clearly material situations in future shadow trading cases.

The jury verdict may not be the final word in this case. Mr. Panuwat may appeal the outcome and bring the question of the SEC’s legal theory before the Ninth Circuit. If so, the odds are that the Ninth Circuit upholds the trial court’s legal conclusions and also views shadow trading as within established law. In any case, the jury’s verdict means that shadow trading is now more firmly established as a type of insider trading – it is no longer “novel” and the SEC will continue to bring shadow trading cases. Investment advisers should assume that SEC examiners will want to see compliance policies and procedures aimed specifically at preventing shadow trading. More broadly, all market participants need to take note of this case to ensure they understand that shadow trading is a form of insider trading.